The term "venture debt" has been tied to loans to venture capital-backed or other sponsor-backed companies for quite some time. TIMIA Capital is advocating for an expansion of the term’s meaning that more accurately reflects the diverse range of debt options that are now available to tech startups.
The term “venture debt” was originally coined by the ill-fated Silicon Valley Bank (SVB) to describe a specific type of debt financing provided to startups that had already raised a significant amount of equity capital from venture capitalists or other equity-based sponsors.
Since then, the venture capital industry has exerted a certain degree of ownership over the term “venture” and created a more narrow definition of “venture debt” that is limited to loans given to venture capital-backed startups.
This narrower definition does not accurately reflect the full range of debt financing options available to startups today. As a result, many industry experts have started using the term “venture debt” more broadly to refer literally to any type of debt provided to a venture.
The recent collapse of Silicon Valley Bank has accelerated the evolution of venture debt, but we believe that there needs to be a conscious effort across the industry to reclaim the term and bring alternative sources of debt financing into the mainstream.
Origins of Venture Debt
Founded in 1983 by Wells Fargo executive Bill Biggerstaff and Stanford University professor Robert Medearis, SVB was the first bank to create loan products for tech startups. Traditional lenders were often hesitant to provide debt financing to startups due to the lack of fixed assets and other factors that made it difficult to assess creditworthiness.
SVB recognized the unique needs of startups and developed a lending model that relied on venture capital support as a key indicator of a startup’s potential for success. They used the venture capital investment as a source of validation and a primary yardstick for underwriting their loans.
SVBs loans were used to lengthen a startup’s runway shortly after an equity raise. The additional capital bought the startup time to grow and achieve a larger valuation before the next raise.
SVB’s approach to lending was a catalyst for the emergence of other debt products that catered to the unique needs of tech startups. Private lenders recognized the value of recurring revenue as an asset and developed debt financing options — such as Term Loans, MRR to ARR Loans, Revenue-Based Financing, and Convertible Debt — to cater to a broader array of tech startups, irrespective of their backing.
Marketers at these private lenders introduced new terms like “tech finance,” “debt capital,” and “non-dilutive finance” to differentiate from SVB-type offerings. However, by redefining “venture debt” to encompass the full range of debt options available to startups, we can reduce confusion and ensure that companies have access to the financing they need to grow and succeed.
The Many Faces of Venture Debt for Tech (And How to Choose the Right One)
The broader definition of venture debt recognizes the diverse financing options available to tech startups, offering a more comprehensive picture of the startup financing landscape which includes many offerings like:
1. Term Loans or Amortized
A term loan is debt financing with a fixed repayment schedule over a set period of time. Term loans are typically used to finance either long-term growth initiatives (3-5 years) or to grow valuations before an exit or a venture capital funding round. Principal payments typically start low and ladder up each year, so startups can put capital to work in the early years. Learn more
|Recommended for: Established startups with a proven track record of revenue that need a significant amount of capital for growth and expansion.||Least suited to: Early-stage startups with little to no revenue, as they may not have the credit history to secure a loan.|
2. Short-Term Loans
Short-term loans have a repayment term of less than one year, often with higher interest rates and no collateral required. Short-term loans are typically used for immediate needs, but should never be used to fund operational expenses. Learn more
|Recommended for: Early-stage startups that need a quick injection of capital to fund short-term needs, such as inventory purchases or unexpected expenses.||Least suited to: Established startups with stable cash flow, as the high-interest rates and short repayment terms may not align with their financial goals and strategies.|
3. MRR to ARR Loans
An MRR to ARR loan is a type of debt financing that allows startups to borrow funds based on their monthly recurring revenue (MRR) or annual recurring revenue (ARR), with repayments tied to revenue. Learn more
|Recommended for: Startups with a proven track record of recurring revenue that need a cash infusion to accelerate a specific, proven initiative that will drive growth.||Least suited to: Startups with inconsistent or unpredictable revenue streams, or that intend to fund larger cash burns, including product development and general and administrative costs.|
4. Revenue Financing Loans
Revenue financing loans are types of debt financing that allow startups to borrow funds based on their current and expected revenue, often without requiring traditional collateral. Learn more
|Recommended for: Startups that have predictable and stable revenue streams and need a way to access capital without diluting equity or providing traditional collateral.||Least suited to: Startups with inconsistent or unpredictable revenue streams or startups that expect fast growth, as the escalating payments may be difficult to manage|
5. Convertible Debt
Convertible debt can be converted into equity at a future date and is often used by early-stage startups to access funding without immediate repayment requirements. Learn more
|Recommended for: Startups that are early in their lifecycle and have a strong potential for future growth, but need a way to access capital without the immediate pressure of traditional debt repayment.||Least suited to: Established startups with no plans for future fundraising or growth, as the potential for dilution of equity may not align with their long-term financial goals.|
6. Factoring or Invoice Loan
A factoring or invoice loan is a type of debt financing where a lender buys a company’s outstanding invoices at a discount, providing immediate cash flow for the company while the lender collects payment directly from the customer. Learn more
|Recommended for: Startups with a lot of outstanding invoices and a need for immediate cash flow, or startups that need to improve their cash flow position to take advantage of growth opportunities.||Least suited to: Startups that have low levels of revenue or an unreliable stream of revenue, as they may not have enough outstanding invoices to factor.|
Changing the Perception of Venture Debt
It is time for the technology finance community to recognize and embrace the broader scope of venture debt, using the term in its literal sense to refer to any type of debt that is provided to a venture.
We also have a role to play in changing the perception of debt.
Over the years, venture capitalists and accelerators have had a love-hate relationship with debt that has given it a bad reputation.
Paul Graham, for example, one of the founding members of Y combinator, has run a long-term smear campaign against debt.
Venture debt is like a delicious sandwich that only costs ten cents, but occasionally explodes in your face.
If I were running a startup, I don’t think I’d ever take it.
— Paul Graham (@paulg) February 7, 2020
Even the best startups often go through near-death experiences. The problem with venture debt is that it tends to turn near-death experiences into death experiences. Avoid it if you can.
— Paul Graham (@paulg) August 6, 2021
The articles recently published by Tech Crunch and Bigfoot Capital exhibit a biased perspective against venture debt. Big Foot Capital, in particular, pushes the narrative that venture debt can only be taken alongside an equity round. Both articles are focused on the larger end of the startup market — the majority of tech startups are not at that stage.
By reclaiming the term venture debt and educating bootstrapping founders on the types of debt, the best time to take debt, and how to use it, we can create a healthier tech financing ecosystem than the one we’ve watched crumble over the past few months.
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